Chapter 26 – Pricing Decisions, Incl. Target Costing and Transfer Pricing
TRUE/FALSE
1. The long-term objectives of a company need not include statements concerning pricing policy.
2. A company that produces standard items for a competitive market should have the same pricing
strategies as a company that makes unique items custom-designed for its customers.
3. A company producing custom-designed products for its customers can be more conservative in its
pricing strategy than a company producing standardized items.
4. In a competitive market, prices can be reduced to gain market share by displacing the sales of
competing companies.
5. Maximizing profits has been and continues to be a dominant factor in price setting.
6. Profit maximization has been tempered by other more socially focused concerns in recent years.
7. A company should never attempt to increase its market share by reducing prices below cost.
8. Companies should be concerned about the effect of their prices on their public image.
9. Legal constraints and ethical considerations should be considered when developing a company’s
pricing policy.
10. A company’s pricing policy objectives may include maintaining a minimum return on investment.
11. Focusing pricing objectives on sales growth can provide a measure of increasing market share as well
as an incentive and target for managers for a period of time.
12. A manager may deviate from the four pricing rules if a specific short-term objective is being targeted.
13. Setting appropriate prices is one of the simplest decisions that managers make on a day–to-day basis.
14. Organizations will not invest in making a product or providing a service unless it will provide a
minimum return.
15. Factors that influence the pricing decision are only external in nature.
16. Both internal and external factors can influence the pricing decision.
17. Each product or service has a target market that determines its demand.
18. The target market for a product or service should be given strong consideration before the final price is
chosen.
19. The primary internal factor to be considered in product pricing is the cost of the product or service.
20. Underlying every pricing decision is the fact that all costs incurred must be recovered in the long run
or the company will no longer be in business.
21. The ability to set the one perfect price will never be achieved because there will always be changes in
circumstances that will justify a different price.
22. Economic theory indicates that as you market a product, price reductions will have to be made to sell
additional units.
23. Under microeconomic theory, total revenue will continue to increase, but the rate of increase will
diminish as more and more units are sold.
24. Beyond the sales level that achieves maximum profits, total costs rise at a slower rate than total
revenue.
25. Marginal revenue is the change in total revenue resulting from a one-unit change in output.
26. Marginal cost is the change in total cost resulting from a one-unit change in output.
27. Auction-based pricing is a pricing method used primarily on the Internet where price is determined by
willing buyers and sellers.
28. The economic approach to pricing is based on microeconomic theory.
29. Within the relevant range, fixed and variable costs are fairly predictable.
30. It is realistic to assume that a total revenue line will curve rather than be straight.
31. A company should not deviate from the traditional approaches to price determination.
32. A good starting point for any pricing method is to develop a price based on the cost of producing the
good or service.
33. Gross margin pricing establishes selling prices at an amount that is a stipulated rate above variable
production costs.
34. Return on assets pricing is based on the estimated number of units to be sold.
35. Gross margin is the difference between sales and the variable production costs of those sales.
36. The numerator in the markup percentage for the gross margin–based pricing method comprises selling
expenses, general and administrative expenses, and a desired profit.
37. The markup percentage includes the gross margin in the computation of the selling price.
38. The denominator of the gross margin markup percentage is total production costs.
39. The gross margin–based price is computed by adding total production costs per unit to the total
production costs per unit times the gross margin markup percentage.
40. The gross margin pricing method computes unit selling price based on production costs rather than
total costs.
41. Return on assets pricing has the same objective as gross margin pricing for the price determination
process.
42. Because a business should have as its primary objective the earning of a minimum rate of return on
assets, the return on assets pricing method has a great deal of appeal and support.
43. For the return on assets pricing method, the desired rate of return on assets per unit is added to the total
costs and expenses per unit to determine the selling price.
44. For the return on assets pricing method, desired earnings are computed by dividing asset costs by
projected units to be produced and then multiplying by the desired rate of return on assets.
45. In gross margin pricing, the markup percentage is based on total production costs.
46. A company will choose a cost-based pricing method based on the degree of trust it has in the cost base.
47. Service-oriented businesses take the same approach to pricing their “product” as product-oriented
businesses.
48. For service-oriented businesses, pricing is determined using cost-based approaches that add the cost of
overhead to materials, parts, and labor via markup percentages.
49. When using a cost-based approach, once the cost of a good or service has been determined, additional
factors need not be considered in establishing a selling price.
50. A target price is an estimate of a price for a product or service that potential customers will be willing
to pay.
51. Computing the target cost for a product is the first step in target costing.
52. When using traditional, cost-based pricing, the pricing decision is made before products have been put
into production.
53. Committed costs are engineered into a product or service at the design stage of product development.
54. A target cost is an anticipated cost that should be achieved at a midpoint in the product’s life cycle.
55. Management accountants are directly involved in designing products that meet target costs.
56. Anticipated market price is taken as a given in target costing.
57. Target costing is a variation of cost-based pricing models that reverses the normal procedure for a
cost-based pricing model.
58. Target costing identifies a competitive price and then subtracts the desired profit to determine a target
cost.
59. Target costing identifies a competitive price and then adds the desired profit to determine a target cost.
60. If engineers determine that a product can be produced for less than its target cost, then production of
the product should not be undertaken.
61. Target costing is a useful pricing tool because it allows the company to critically analyze the potential
for success of a product before committing resources to its production.
62. Transfer prices are used for internal decisions and performance evaluation purposes and are not made
known to the outside world.
63. A set of rules similar to those used to set external prices governs the establishment of transfer prices.
64. Transfer prices force segments of a business to compete for the company’s resources.
65. Transfer pricing can influence operating efficiency and profitability.
66. Profit measurement and return on investment for decentralized divisions are important gauges for
performance evaluation.
67. The pricing of intracompany transactions should not have an effect on the determination of the product
cost and the selling price to external customers.
68. A transfer price is the price at which goods are exchanged among company divisions.
69. A transfer price should not contain any profit since the profit for a product should be determined when
the product is completed.
70. Transfer prices affect the revenues and costs of the divisions involved but do not affect the revenues
and costs of the company as a whole.
71. The concept of transfer pricing is widely accepted because of its ability to assist in performance
evaluation of managers in a company with decentralized divisions.
72. Transfer pricing can create problems if a company division can purchase inputs outside of the
company at a price lower than the internal transfer price from another division.
73. Transfer pricing can create problems if a company division can sell its output outside the company
rather than transfer its output to another division within the company.
74. A negotiated transfer price is often used for internal pricing.
75. One approach to the development of a transfer price is to use the market value if the item has an
existing market at the time of transfer.
76. The cost-plus transfer price is the sum of the costs incurred by the producing division plus an
agreed-upon profit percentage.
77. The weakness of a negotiated transfer price is that cost recovery is guaranteed to the selling division,
which may lead to failure to detect inefficient operating conditions and excessive cost incurrence.
78. A negotiated transfer price is one that is bargained for between the managers of the buying and selling
divisions of a company.
79. A negotiated transfer price will be between the negotiation floor and the negotiation ceiling.
80. A transfer price can be based on a market price for products that has been reduced in the process of
bargaining by division managers.
81. Using a market transfer price would cause the selling division manager to sell directly to an outside
customer rather than transferring goods to a buying division manager.
82. The weakness of the cost-plus pricing method is that cost recovery is guaranteed to the selling
division.
83. Overall company profits are rarely affected if a division sells to an outside customer to generate
profits, even if this causes an internal shortage of materials.
84. The use of transfer pricing encourages accountability for seller-customer relationships.
85. The market price must be included in the analysis of a transfer price if the semi-finished product has
an existing market for the selling division to consider.
86. The market price need not be included in the analysis of a transfer price if the semi-finished product
can be purchased in a similar condition by the buying division.
87. Negotiation between managers is not appropriate in determining an appropriate transfer price.
88. Overhead costs allocated to divisions from corporate levels should be incorporated in the computation
of the transfer price.
89. The selling division may use a transfer price different from that used by the division buying the item
being transferred in order to evaluate the performance of the managers.
90. Different transfer prices may be used by the selling and buying divisions to avoid problems between
the managers of the divisions.
91. Transfer prices are often called artificial or created prices.
92. A selling division with adequate capacity to fulfill the demand of the buying division should sell to the
buying division at any price that recovers incremental costs.
93. Cost and price information are irrelevant to transfer prices.
94. Overall company profits will not be enhanced if a buying division acquires products from outside
suppliers at an annual cost that is less than the incremental cost to the supplying division within the
company.
MULTIPLE CHOICE
1. An example of a pricing objective is to
a.
have prices that top the market.
b.
maintain or gain market share.
c.
maximize losses.
d.
minimize quality and cost.
2. An example of a pricing objective is to
a.
ignore long-term pricing strategies in favor of short-term profits.
b.
increase market share irrespective of the cost of a product.
c.
maintain a price that is always under that of the competition.
d.
maintain a minimum rate of return.
3. The pricing objective of maximizing profits
a.
has not been affected by other, more socially focused concerns.
b.
is to be implemented under any and all circumstances.
c.
has not always been considered the underlying objective of any pricing policy.
d.
must be considered when determining the price needed to increase market share.
4. To stay in business, a company must have a selling price that is
a.
acceptable to the customer.
b.
able to recover the variable costs of production.
c.
the highest in the marketplace.
d.
equal to or lower than the company’s costs per unit.
5. When making the decision on a product’s price, the manager must consider
a.
all products at the same time.
b.
the minimum price that will produce a profit.
c.
only cost-based information.
d.
the product’s total variable costs.
6. An internal issue to be considered when setting a price is
a.
whether the process is labor-intensive or automated.
b.
the customer’s preferences for quality versus price.
c.
current prices of competing products or services.
d.
the life of the product or service.
7. An external issue to be considered when setting a price is
a.
the quality of materials and labor.
b.
total demand for the product or service.
c.
usage of scarce resources.
d.
the variable costs of the product or service.
8. An internal issue to be considered when setting a price is
a.
whether there is a sole source or heavy competition.
b.
the life of the product or service.
c.
a price geared toward a minimum return on investment.
d.
whether there is seasonal demand or continual demand.
9. An external issue to be considered when setting a price is
a.
the variable costs of the product or service.
b.
the desired rate of return.
c.
the quality of materials and labor.
d.
the number of competing products or services.
10. An internal issue to be considered when setting a price is
a.
whether there is a sole source or heavy competition.
b.
total demand for the product or service.
c.
the quality of material and labor.
d.
the number of competing products or services.
11. An external issue to be considered when setting a price is
a.
the quality of competing products or services.
b.
the quality of materials and labor.
c.
a price geared toward a minimum return on investment.
d.
the total costs of the product or service.
12. Fixed costs that change for activity outside the relevant range would include
a.
supervision costs.
b.
electricity costs.
c.
production supplies costs.
d.
raw materials costs.
13. A pricing method based on product cost is
a.
cost of goods sold pricing.
b.
net income pricing.
c.
gross margin pricing.
d.
inventory pricing.
14. When gross margin pricing is used, the markup percentage includes
a.
desired profits plus total selling, general, and administrative expenses.
b.
only the desired profit factor.
c.
total costs and expenses.
d.
desired profits plus total fixed production costs plus total selling, general, and
administrative expenses.
15. The return on assets pricing method
a.
has very little appeal and support.
b.
has a primary objective of earning a minimum rate of return on assets.
c.
is a crude approach to pricing and should be used as a last resort.
d.
replaces the desired rate of return used in cost-based pricing methods with a desired profit
objective.
16. Pricing of services
a.
requires the same approach as pricing of products.
b.
uses a markup percentage to add the cost of overhead to the direct costs of labor,
materials, and parts.
c.
always requires three pricing computations, one for materials, one for parts, and one for
labor.
d.
is less accurate than pricing of products.
17. The state of Illinois has passed a law requiring that every automobile be inspected at least once a year
for pollution control. Anfang Enterprises is considering entering into this type of business. After
extensive studies, Joseph Anfang has developed the following set of projected annual data on which to
make his decision:
Direct service labor
$363,000.00
Variable service overhead costs
270,000.00
Fixed service overhead costs
280,000.00
Marketing expenses
120,000.00
General and administrative expenses
170,000.00
Minimum profit
90,000.00
Cost of assets employed
500,000.00
Anfang believes that his company will inspect 100,000 automobiles per year. The company earns an
average of 18.75 percent return on its assets.
The projected cost for inspecting each automobile would be
a.
$11.13.
b.
$12.03.
c.
$12.93.
d.
$10.03.
18. The state of Illinois has passed a law requiring that every automobile be inspected at least once a year
for pollution control. Anfang Enterprises is considering entering into this type of business. After
extensive studies, Joseph Anfang has developed the following set of projected annual data on which to
make his decision:
Direct service labor
$363,000.00
Variable service overhead costs
270,000.00
Fixed service overhead costs
280,000.00
Marketing expenses
120,000.00
General and administrative expenses
170,000.00
Minimum profit
90,000.00
Cost of assets employed
500,000.00
Anfang believes that his company will inspect 100,000 automobiles per year. The company earns an
average of 18.75 percent return on its assets.
The price to be charged for inspecting each automobile using the return on assets pricing method
would be calculated as follows:
a.
($913,000.00 ÷ 100,000) + {($913,000.00 ÷ 100,000) [($90,000 + $290,000) ÷
$913,000.00]}
b.
($1,203,000.00 ÷ 100,000) + [($1,203,000.00 ÷ 100,000) ($90,000 ÷ $1,203,000.00)]
c.
($1,203,000.00 ÷ 100,000) + [($500,000 ÷ 100,000) 0.1875]
d.
None of these
19. The state of Illinois has passed a law requiring that every automobile be inspected at least once a year
for pollution control. Anfang Enterprises is considering entering into this type of business. After
extensive studies, Joseph Anfang has developed the following set of projected annual data on which to
make his decision:
Direct service labor
$363,000.00
Variable service overhead costs
270,000.00
Fixed service overhead costs
280,000.00
Marketing expenses
120,000.00
General and administrative expenses
170,000.00
Minimum profit
90,000.00
Cost of assets employed
500,000.00
Anfang believes that his company will inspect 100,000 automobiles per year. The company earns an
average of 18.75 percent return on its assets.